BOU orders banks to cut lending rate

BUSINESSThe warning was contained in a letter by the Governor of Bank of Uganda (BOU), Prof. Emmanuel Tumusiime Mutebile on Tuesday, to all chief executive officers of commercial banks, and copied to the Uganda Bankers Association.

In the letter, which the New Vision has seen, Mutebile said he was disheartened that lending rates were not reducing, despite a raft of reductions to the benchmark Central Bank Rate (CBR) since 2016.

The CBR was slashed by 200 basis points to 7%, the lowest ever, between April and June, to counter the effects of the coronavirus on the economy. However, the weighted average industry lending rates rose to 18.8% in May, from 17.7% in April, against BOU's signal for a reduction.

The CBR is the benchmark rate at which financial institutions borrow from the central bank. When a bank is facing liquidity (cash) challenges, they borrow money from the central bank or from other banks, using the CBR as the benchmark rate.

The lockdown has adversely affected borrowers' ability to meet their loan obligations with several commercial banks.

Mutebile's warning

"Since BOU has aggressively eased monetary policy with an objective of reducing the cost of credit, lending interest rates should be reduced to levels that are consistent with the current monetary policy stance," Mutebile said.

"In view of commercial banks' reluctance to heed this call, BOU may take redress to section 39 (1) (d) of the Bank of Uganda Act (2000)."

The law allows for BOU, in consultation with the finance minister, to determine maximum and minimum rates that financial institutions may impose on loans.

The sector regulator said the "downward stickiness in lending rates, despite BOU's accommodative monetary policy" stance could leave more businesses and households suffering from the effects of the COVID-19 pandemic.

"A faster recovery of the economy reduces the likelihood of distress in the financial sector. I, therefore, expect a faster reaction to the CBR reduction by commercial banks," he said.

BOU cut the central bank rate (CBR) by 200 basis points to 7%, in June, aiming to cushion the economy and encourage lending to households and businesses battered by the effects of the lockdown.

Lending rates on shilling loans averaged 24.7% in the three months to April 2016 and have been nearly unchanged for most banks in 2020. Central bank data indicates that in January, Centenary Bank's best (prime) rate was 21%, Cairo International Bank 23%, Equity Bank Uganda Limited 22%, Standard Chartered 19.3%, Stanbic Bank Uganda Limited 17.5%, Housing Finance 21%, dfcu 21%, and Absa 19.75%.

If the central fixed interest rate, old loan holders would need to refinance their loans to enjoy revised interest rates, payment schedules and other terms. The latest Stanbic Purchase Managers Index (PMI) report indicated that economic activity has contracted due to the coronavirus.

The survey showed that companies reported difficulties in paying staff in June and this led to job cuts and a reduction in salaries across the board.

Commercial banks react

Anthony Kituuka, the executive director of Equity Bank Uganda Limited, said they would look at their prime lending rate, with a view of lowering it in line with the governor's letter.

Anne Juuko, the Stanbic Bank Uganda's chief executive officer, said Stanbic has cut its prime lending to 16% from 16.5% to support the economy. She pointed out that at industry level, approximately 14%, or sh2.02 trillion, of the total banking loan portfolio of sh14.7 trillion in April has been restructured.

"Over 1,300 loans have been restructured and the majority is within the SME (Small and Medium Enterprise) sector," she said, adding that Stanbic Bank has lowered its lending rates in line with the CBR.

"Our spend for the half year is 150%, over and above our budget, to ensure we provided the much-needed support to communities and the Government," Juuko said.

Wilbrod Owor, the executive director at the Uganda Bankers' Association, said: "We received the letter from BOU and we have a meeting today with the members. We shall share our approaches and the way forward. There is no such thing like putting a cap on interest rates.

Financial experts weigh in

Experts have warned of distortions in economic activity, should BOU go ahead to cap interest that commercial banks can charge borrowers.

Nicolas Malaki, an analyst at Chartered Financial, said banks are acting rationally in spite of the central bank measures, because the perceived risk is now higher, meaning the reward should be as well.

He pointed out that banks still have viable options to invest excess deposits, like Government bonds and bills.

"When they put a cap at say 15% and government treasuries are paying between 11% and 15%, then banks will pile for the treasuries. Caps will achieve short term objectives but disastrous in the longer term," he warned.

However, Stephen Kaboyo, the CEO of Alpha Capital Partners, said the central bank seems to have run out of patience and that this response is a reality check.

He said the central bank has been using the moral persuasion approach to convince commercial banks to respond to the accommodative monetary policy stance, but this has fallen on deaf ears.

He said the CBR policy rate has had little effect on commercial banks' liquidity management and pricing, which essentially means that there has been a weak monetary policy transmission.

Kaboyo pointed out that banks will have to take a closer look at the changing market conditions in these uncertain times and that managing balance sheets is going to be complicated.

He said they will have no choice, but to reset their revenue outlooks, change their financial assumptions, tweak their business models and review and restructure their operations, in light of the current market environment.

Doreen Mugisha, a clients and markets development manager at audit firm PricewaterhouseCoopers, noted in a blog post that the causes of the high interest rates in Uganda should be addressed.

"The legislation may fix the interest rate to make it affordable, but it will deny many borrowers access to credit. What borrowers want is both affordable and accessible credit," she said.

Factors of lending rates

In their Working Paper, published in June last year, titled: What Explains High Lending Interest Rates in Uganda?, researchers Adam Mugume and Doreen Katangaza Rubatsimbira from Bank of Uganda, stated that: "The factors that determine the level of commercial bank lending rates are important concerns to policymakers, the banking industry and the public at large.

From a policy perspective, lower lending rates are desirable, as they tend to have a positive influence on new and existing investments, thus contributing to growth and development."

"There is little doubt that lending interest rates have been a sensitive and recurring policy issue, one which requires an objective examination of all contributing factors.

The macroeconomic environment has improved markedly and the financial sector has undergone extensive reforms. Whilst there has been a reduction in average commercial bank lending rates, in response to a reduction in inflation and the relatively low monetary policy rate (CBR), they remain prohibitively high and restrict many private sector borrowers from accessing the credit markets."

"The high lending rates are mainly on account of high overhead costs. Thus, reducing the high lending interest rates will require a reduction in operating costs of the banks.

The degree to which banks will be able to operate on a lower spread brings the issue of operating efficiency to the fore. As experience has shown, the process of consolidation and rationalisation is not instantaneous and involves heavy initial costs.

Nonetheless, some features of modern consumer banking, which contribute to lower operating costs are increasingly enjoyed in Uganda today."

"Broadly, a stable macroeconomic environment, banking business growth, promotion of financial literacy, bank penetration through agent banking, and the overall financial sector development will cause lending interest rates to decline, though gradually